Investing Retirement Wealth: a Life-Cycle Model

49 Pages Posted: 20 Apr 1999 Last revised: 12 Oct 2010

See all articles by John Y. Campbell

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Joao F. Cocco

London Business School; Centre for Economic Policy Research (CEPR)

Francisco Gomes

London Business School

Pascal J. Maenhout

INSEAD - Finance

Multiple version iconThere are 2 versions of this paper

Date Written: March 1999

Abstract

If household portfolios are constrained by borrowing and short-sales restrictions asset markets, then alternative retirement savings systems may affect household welfare by relaxing these constraints. This paper uses a calibrated partial-equilibrium model of optimal life-cycle portfolio choice to explore the empirical relevance of these issues. In a benchmark case, we find ex-ante welfare gains equivalent to a 3.7% increase in consumption from the investment of half of retirement wealth in the equity market. The main channel through which these gains are realized is that the higher average return on equities permits a lower Social Security tax rate on younger households, which helps households smooth their consumption over the life cycle. There is a smaller welfare gain of 0.5% of consumption when Social Security tax rates are held constant. We also find that realistic heterogeneity of risk aversion and labor income risk can strongly affect optimal portfolio choice over the life cycle, which provides one argument for a privatized Social Security system with an element of personal portfolio choice.

Suggested Citation

Campbell, John Y. and Cocco, João F. and Gomes, Francisco and Maenhout, Pascal J., Investing Retirement Wealth: a Life-Cycle Model (March 1999). NBER Working Paper No. w7029. Available at SSRN: https://ssrn.com/abstract=155868

John Y. Campbell (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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João F. Cocco

London Business School ( email )

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Centre for Economic Policy Research (CEPR)

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Francisco Gomes

London Business School ( email )

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London NW1 4SA
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HOME PAGE: http://www.london.edu/faculty/fgomes

Pascal J. Maenhout

INSEAD - Finance ( email )

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F-77305 Fontainebleau Cedex
France

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